How Abbott Labs Reaches $67 Fair Value

This year through October, big pharmaceutical companies have seen a surge in their stock prices. With close to 30-35% return, Abbott Labs (NYSE:ABT) has outperformed the overall healthcare sector. But the stock slumped almost 10% from the highs seen in October after it announced results. However, we believe the company will bounce back based on our $67 price estimate, barring no major negative developments in the U.S. economy and the market. Below, we discuss the factors that could take the company’s stock back to our price estimate.

In the pharmaceuticals segment, we expect overall pharmaceutical sales to increase in the near term backed by key proprietary drugs including Humira, AndroGel and Creon. Further, there are no major patent expiries in the near term except for Tricor, which went off-patent in July. Humira is Abbott’s single largest source of revenues and the undisputed leader in the treatment of rheumatoid arthritis. The drug garners close to $8 billion in sales. While the drug’s growth now seems to be slowing down, as witnessed in the last quarter, it is still significantly higher at 10%, considering the higher base sales.

Further, as competition grows, we anticipate the drug to exhibit mid-single digit growth, taking its sales to top $10 billion by 2013. It may be difficult to change a physician’s prescription habits for biologics, which could reduce the gravity of the competition. Also, the company is banking on expanding the drug’s base to new indications to fend off competition from new entrants. The addition of new indications may continue to drive growth for Humira. Other drugs like Androgel (testosterone gel) also continue to see strong demand growth.

In addition, the company acquired Solvay and Piramal’s Healhcare solutions business to diversify its portfolio by adding generics and expand into emerging markets. Abbott also struck a R&D deal with ChemDiv Research Institute (CDRI), a part of Russian R&D group ChemRar High Tech Center.

Emerging markets are expected to grow at double-digit rates, much faster than the developed U.S. and European markets. Per capita income levels in many emerging markets are also rising rapidly, which should lead to better insurance coverage and healthcare. Additionally, new studies and better access to information have led to rising health consciousness in these markets. The acquisitions place the company well to tap the substantial growth opportunities. We believe the company will be able to leverage its global footprint and strong brand to take advantage of untapped opportunities and drive further growth in these markets. However, ineffective patent laws in many of these countries have proven to be a hurdle for large pharmaceutical companies.

As the emerging markets will see their revenue share increase, the company’s EBITDA margins could decline, as margins from international markets are usually lower than that of the U.S. market due to higher price sensitivity among consumers. However, we have already incorporated these factors into our forecast.

Our concerns are aroused by the fact that the company doesn’t have many blockbuster potential candidates in its phase III pipeline, which could hurt Abbott after it loses patent protection for Humira in 2016. The company’s partner, Reata Pharmaceuticals, recently announced that it will discontinue a late-stage trial of its potential blockbuster drug for chronic kidney disease and diabetes due to safety concerns raised by an independent safety committee. This has also already been factored in by the market.

A couple of days ago, the company’s experimental hepatitis C drug showed promising results in phase II clinical trials. We will wait for further details before taking any stand.

Nutritionals – These include pediatric, adult, healthy living and sports nutrition products, such as infant formulas, snack bars and meal replacement shakes.

After facing a setback following voluntary recall of infant formula Similac in 2010, the company has started to regain consumer confidence and market share. Abbott's pediatric nutritional registered high single digit growth in the last couple of quarters largely due to Similac and other pediatric nutritional products like PediaSure, Ensure and Glucerna. We expect the company to maintain the momentum on new product launches, coupled with its strong position in the rapidly growing emerging markets.

Abbott has been building manufacturing facilities in the huge and untapped China. However, this is not the only country the company is focusing on. It recently opened a nutritional R&D center and a manufacturing unit in India, which will help Abbott develop affordable nutrition products for malnutrition and diabetes while addressing local preferences for taste and texture. The company is also considering adding local sales and distribution functions in this facility. We believe that such moves will certainly help the company increase its penetration in emerging markets, which will boost sales.

This segment has been the company’s largest contributor to growth of late due to the success of its XIENCE/PROMUS coronary stents. While the division is seeing a sharp decline in revenues in the short term, it is mostly due to certain royalty and supply arrangement revenues (including Promus) and currency impact. However, even with a strong U.S. dollar, we expect the company to pick up its market share going forward.

Abbott’s Absorb is the world’s first drug-eluting bioresorbable (doesn’t require mechanical removal) vascular scaffolds. In addition, Abbott launched MitraClip in Europe, which treats the most common heart valve defects in the world, which is estimated to affect 8 million people in the United States and Europe. Further, the company recently launched its next generation Drug Eluting Stent (DES) XIENCE Xpedition in Europe, and expects to launch the product in the U.S. in 2013. These factors should drive growth for Abbott’s vascular franchise.

Diagnostics - These include systems and tests used for screening for drugs of abuse, cancer, therapeutic drug monitoring, fertility, physiological diseases and infectious diseases such as hepatitis and HIV.

The division has shown consistent growth in the last couple of quarters due to an increase in demand. We foresee an increase the company’s market share going forward.

Abbott has made several acquisitions, including Starlims Technologies and Ibis Biosciences. Through the Starlims Technologies acquisition, Abbott added laboratory informatics systems to its diagnostics segment. The Ibis Biosciences acquisition has strengthened Abbott’s position in the fast growing market for molecular diagnostics for infectious disease. We think the company should be able to leverage its global brand and scale to increase its market share in the in-vitro diagnostic market. Further, Abbott has a strong presence in rapidly growing markets like China, India, and Brazil through other businesses.

We believe the recent sell-off in the company’s stock following the results announcement and setback from Reata Pharmaceuticals may be overdone following fiscal cliff worries. As these concerns subside, the stock could once again move toward its fair value of $67. Abbott is in the process of splitting its business into two distinct companies to unlock value, and our current analysis does not reflect the planned split (Read Abbott Labs: A Look At The Company Post Spin-Off).